Interest Rates Run Out of Gas

March 1, 2024

From the Desk of Ian Culley @IanCulley

US Treasuries are taking a back seat to risk assets.

Bond market volatility is declining. Credit spreads are tightening. And Emerging Market high-yield bonds ($EMHY) are breaking out.

Meanwhile, stocks are posting new all-time highs.

So, how high will interest rates climb over the near term?

My gut tells me not far — at least not in the coming weeks or months…

Check out the US benchmark rate finding resistance at approximately 4.33:

Last month’s high marks a logical ceiling for the US benchmark rate.

Those former highs coincide with a key retracement level based on the run-up into the October 2023 peak. Plus, the 10-year yield paused at the same level for almost a month during last year's rally. That’s not a coincidence.

If the US 10-year breaks above 4.33, volatility will hit risk assets, and energy stocks will likely assume a leadership role.

But a continued rise in US yields seems unlikely now that investors have unwound their aggressive 2024 rate cut projections.

Yet yields aren’t rolling over…

Here’s the US 10-year holding above a retracement level from the 2023 Q4 decline at approximately 4.25:

The US 10-year yield will likely cling to this psychological level for the rest of Q1.

Speculative growth names are ripping. Japanese stocks are hitting new all-time highs. And the commodity bull run is spreading to cocoa and cotton futures. (It doesn’t sound like rate-cut fodder to me.)

Two opposing forces bind US yields: The underlying uptrend in rates and a market aligning with the Fed.

Yields will churn sideways as long as both forces remain relevant.

What am I missing?

Do rates catch higher from here?

Or will the Fed start cutting in May?

-Ian

Countdown to FOMC

The market is pricing an initial 25-basis-point rate cut at the June meeting.

Here are the target rate probabilities based on fed funds futures: